Inflation slumps to a five-year low

Inflation has sunk faster than expected to hit a five-year low last month, official figures showed.

The Consumer Prices Index (CPI) for September stood at 1.1% - down from August's 1.6% - as hikes in household energy bills in 2008 compared with unchanged bills for the same month this year.

The fall to CPI's lowest level since September 2004 caught economists by surprise and put further strain on the pound, which edged another step closer to parity against the euro.

The bigger-than-expected fall is likely to give the Bank of England extra room to manoeuvre as it considers whether to extend its quantitative easing programme from £175 billion. Interest rates are already at a record low of 0.5%.

However, experts warned of inflation rises in the months to come, particularly given the impact of last year's VAT discount, which will be removed in January.

David Page, an economist at Investec Securities, said CPI in September was much weaker than the market's expectation of 1.3%. But he said across the year inflation had been unexpectedly resilient and predicted the rise in VAT from the current rate of 15% to 17.5% in January could cause the measure to jump to 3% - well above the Bank of England's 2% target.

He said: "Despite the bigger-than-expected drop in inflation this month, we have been surprised how little inflation has declined this year," he said.

"We think that the sharp drop in sterling, rising second hand car prices, firmer-than-expected oil prices and sticky utility tariffs have all contributed to a more persistent rate of inflation than we expected."

The official figures were dominated by the effect of gas, electricity and other fuel prices, which slumped to minus 7.3% in September from a positive rate of 4.2% in August. It is the lowest figure since the ONS measure began in 1997. The housing and household service sector, which includes energy prices, fell to minus 1.1% across the month, also the lowest figure on record.

Food prices fell 0.9% between August and September, its largest decline across those two months since 2006. Meat prices fell in the month, compared with a rise last year, while there was also a small downward effect from fruit, particularly bananas.